Sovereign Default and Imperfect Tax Enforcement

48 Pages Posted: 7 Jun 2019

See all articles by Francesco Pappadà

Francesco Pappadà

Banque de France; Paris School of Economics (PSE)

Zylberberg Yanos

Visa

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Date Written: June 2019

Abstract

We show that tax compliance is volatile and markedly responds to fiscal policy. To explore the consequence of this novel stylized fact, we build a model of sovereign debt with limited commitment and imperfect tax enforcement. Fiscal policy persistently affects the size of the informal economy, which impact future fiscal revenues and thus default risk. This mechanism captures a key empirical regularity of economies with imperfect tax enforcement: the low sensitivity of debt price to fiscal consolidations. The interaction of imperfect tax enforcement and limited commitment strongly constrains the dynamics of optimal fiscal policy. During default crises, high tax distortions force the government towards extreme fiscal policies, notably including costly austerity spells.

Keywords: Sovereign Default, Imperfect Tax Enfor cement, Fiscal Policy

JEL Classification: E02, E32, E62, F41, H20

Suggested Citation

Pappadà, Francesco and Yanos, Zylberberg, Sovereign Default and Imperfect Tax Enforcement (June 2019). Banque de France Working Paper No. 722, Available at SSRN: https://ssrn.com/abstract=3400076 or http://dx.doi.org/10.2139/ssrn.3400076

Francesco Pappadà (Contact Author)

Banque de France ( email )

Paris
France

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

Zylberberg Yanos

Visa ( email )

The Priory Road Complex
Clifton
Bristol, BS8 1TU
United Kingdom

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